FHA loans and conventional loans are popular options among homebuyers. FHA loans come with more relaxed credit score requirements, while conventional loans allow you to forgo mortgage insurance if you have a high enough down payment.
What is an FHA loan?
An FHA loan is backed by the Federal Housing Administration and protects the lender if the borrower defaults. An FHA loan also:
- Requires a credit score of at least 500
- Requires mortgage insurance premiums (MIPs), regardless of your credit score or down payment amount
- Helps people who otherwise wouldn’t qualify for home financing
What is a conventional loan?
A conventional loan is the most common type of mortgage, but it has no government guarantee. A conventional loan also:
- Requires a credit score of at least 620
- Requires you to buy private mortgage insurance (PMI) if you place less than 20% down
- Can have less costly PMI payments compared to FHA mortgage insurance
Here’s a quick look at how FHA loans and conventional loans compare:
The differences between FHA and conventional loans
FHA loans have more relaxed financial standards but stricter property standards and mortgage insurance requirements. Conventional loans, on the other hand, have stricter financial standards but more relaxed property standards and mortgage insurance guidelines.
Credit score requirements
FHA loans
Credit score standards are generally less stringent for FHA loans than for conventional loans. You only need a credit score of 580 to qualify with 3.5% down. If your credit score is 500 to 579, FHA loan guidelines require you to put 10% down.
Good to know
Lenders typically require higher credit scores to qualify for any home loan. To get an FHA loan, for example, your lender might ask you to have a score of at least 620.
Conventional loans
Conventional loans often require a credit score of at least 620, but as with FHA loans, some lenders may require a higher score. The higher your credit score, the better your interest rate is likely to be.
Here’s how your credit score can affect mortgage rates:
Debt-to-income requirements
Your debt-to-income ratio, or DTI, is a percentage that tells lenders how much of your total monthly income goes toward debt payments such as your car loan and student loan.
Here’s how to calculate your DTI:
(Total monthly debt) / (Gross monthly income) x 100 = DTI
FHA loans have the same standards as conventional loans when it comes to DTI.
FHA loans
- 50% maximum DTI
Conventional loans
- 45% maximum DTI
Keep in mind that the maximum DTI may not apply to your situation; lenders only allow these maximums if you’re an otherwise strong borrower with compensating factors such as a couple of months’ worth of cash reserves and a higher credit score.
Down payment
There’s a common misconception that if you need a low-down-payment loan, you’ll have to get an FHA loan. In reality, you can get a conventional loan with as little as 3% down.
FHA loans
As mentioned before, if your credit score is at least 580, you can put down as little as 3.5% on an FHA loan. If your credit score is 500 to 579, you’ll have to put down at least 10%.
Let’s say you’re buying a home that costs $225,000. If you put down 3.5%, you’ll need $7,875. If you put down 10%, you’ll need $22,500.
Conventional loans
Putting 20% down on a conventional loan will reduce your monthly payment and allow you to forgo PMI, but you can potentially put down as little as 3%. On a $225,000 loan, that would amount to $7,750, even less than what you’d need for an FHA loan.
Tip
One way to get a conventional loan with a low down payment is to opt for Fannie Mae’s 97% LTV Standard mortgage — also known as a Conventional 97 loan. This loan allows 3% down as long as at least one borrower is a first-time buyer.
You can only use a Conventional 97 loan to buy a primary residence, and you must get a fixed-rate loan with a term of no longer than 30 years.
Loan limits
The loan limit for both FHA loans and conventional loans varies depending on where you live. The FHA loan limit is substantially lower almost everywhere, however. How much you can borrow will also depend on what you can afford with your income and debt, so you may not be able to borrow up to the loan limit for your area.
FHA loan
For single-family homes, the 2021 loan limit for FHA loans is:
- $356,362 in most low-cost areas
- $822,375 in most high-cost areas
An exception exists for Hawaii, Alaska, Guam, and the U.S. Virgin Islands, where single-family buyers can borrow up to $1,233,550. These limits can change from year to year.
See the FHA loan limit in your area: The best way to find out the FHA loan limits in your area is by using this searchable resource from the Department of Housing and Urban Development. Just enter the county or metro area you live in, along with the state, and make sure “FHA Forward” is selected as the loan type.
Conventional loan
If you’re getting a conventional loan, you can’t borrow more than the conforming loan limit, which is:
- $548,250 in most areas
- $822,375 in certain high-cost areas, including Hawaii, Alaska, Guam, and the U.S. Virgin Islands.
Again, these are the limits for single-family homes, and the limits can change each year.
Tip: Try Fannie Mae’s tool to find the conforming loan limit for your area.
If you want to borrow more than the conforming loan limit and have the income to support it, you’ll need to shop for a jumbo loan. These loans require a larger down payment and stronger credit.
Mortgage insurance
Mortgage insurance protects the lender if you can’t make your monthly payments. Both FHA loans and conventional loans have mortgage insurance, but their differences are significant.
FHA loans
Mortgage insurance premiums are mandatory for FHA loans regardless of how much you put down. The two premiums you’ll encounter are:
- Upfront mortgage insurance premium: Every borrower pays this. It’s 1.75% of the loan amount, and you can roll it into your loan.
- Annual mortgage insurance premium: If you put down 10% or more, you’ll pay mortgage insurance premiums for 11 years. If you put down less than 10%, you’ll pay MIPs for the life of your loan, usually 15 or 30 years.
How much does the annual mortgage insurance premium cost? It depends on your loan term, down payment, and loan amount.
For example: Say you put down 3.5% on a $225,000 home, your loan amount will be $217,125. For a 30-year, fixed-rate mortgage, your annual mortgage insurance premium will be 0.85% of $217,125, or $1,845.56. This means you’ll likely pay $153.80 a month in mortgage insurance.
If you get an FHA loan, it’s possible to refinance into a conventional loan down the road to eliminate mortgage insurance once you have 20% equity. But keep in mind you’ll have to pay closing costs on your new loan, and home values and interest rates may change unfavorably over that time.
Conventional loans
With a conventional loan, you’ll need to pay PMI if you don’t put at least 20% down. As with an FHA loan, the cost will depend on your loan term, down payment, and loan amount. Your credit score and loan type are also a factor.
Tip
PMI rates are higher on adjustable-rate loans than on fixed-rate loans.
Let’s again use a $225,000 purchase price for our example and consider the low and high ends of what private mortgage insurance could cost on a 30-year, fixed-rate mortgage.
- High end: 3% down payment, 660 credit score: 1.50% annual premium, $272.81 monthly payment
- Low end: 15% down payment, 760 credit score: 0.19% annual premium, $30.28 monthly payment
Property restrictions
FHA loans have more restrictions than conventional loans when it comes to the property itself. Not only are FHA loans limited to primary residences, but they also come with more explicit standards for the property’s condition.
FHA loans
An FHA loan will require a home appraisal. The appraiser must follow strict requirements from the FHA to evaluate whether the property is safe, sound, and secure.
Here are a few standards the property must meet:
- Proper site drainage
- Safe drinking water
- Safe and comfortable heating
- Watertight roof with at least two years of life left
Learn More: FHA Approved Condos: How to Find One
Conventional loans
Conventional loans can be used for second homes, rental homes, and houses to be flipped, as well as for primary residences. A home purchased with a conventional loan must also be safe, sound, and secure.
Tip: If you want to buy a fixer-upper, Fannie Mae and Freddie Mac offer renovation mortgages specifically for that.
When FHA loans make sense
FHA loans are best for borrowers with lower credit scores and higher debt-to-income ratios who want to pursue homeownership now rather than waiting until their credit, debt, or income improves. This might sound like you if you’re a first-time homebuyer.
People aren’t robots, and we don’t buy homes purely based on financial analysis. Personal circumstances can make homeownership more appealing than renting even if you can’t get an ideal mortgage.
Learn More: Programs for First-Time Homebuyers
When conventional loans make sense
Because they’ll generally be cheaper in the long run, conventional loans are best for borrowers with higher credit scores and lower debt-to-income ratios.
Which loan option might be best for you?
FHA vs. conventional loans: Summary
FHA loans have more lenient credit score requirements: just 500 if you can put down 10%, and 580 if you can put down 3.5%. Because of these looser standards, you’ll have to pay for upfront mortgage insurance. In many cases, you’ll also be responsible for monthly mortgage insurance premiums for the life of the loan.
Conventional loans require you to have a credit score of at least 620. The minimum down payment is 3%, and you’ll typically have to pay PMI unless you put down at least 20%.
With a conventional loan’s tighter requirements, you can purchase a primary, secondary, or investment home and borrow up to $548,250 in most areas. With an FHA loan, you can only purchase a primary residence and borrow up to $356,362 in most areas.
Frequently asked questions
If you’re still not sure whether an FHA loan or a conventional loan is a better choice for you, the answers to these frequently asked questions may help you decide. Keep in mind that there’s no harm in applying for both types with several lenders to see which option is the most affordable.
Which is a better loan, FHA or conventional?
A conventional loan is better in the sense that it’s less expensive if you have excellent credit and a 20% down payment. You may qualify for lenders’ best interest rates and you won’t have to pay for private mortgage insurance.
An FHA loan is better if your credit score isn’t great. With a score of 580 to 619, you can qualify for an FHA loan, but not a conventional loan.
Then there are all the in-between scenarios. Say you have good but not great credit and can put somewhere between 3.5% and 19.9% down. You’ll want to compare the cost of FHA mortgage insurance with the cost of PMI.
How long you plan to keep your loan matters, too. FHA mortgage insurance lasts for the duration of the loan when you put down less than 10%, but you can drop PMI when your equity reaches 20%.
Why do sellers prefer conventional over FHA?
A seller who wants to close quickly may prefer a borrower with conventional loan pre-approval. That’s because an FHA loan typically takes four to seven days longer to close than a conventional loan, according to data from ICE Mortgage Technology, a company that provides cloud-based mortgage origination services to lenders.
